Step 1: Flow-Through Entity versus C-Corporation.
A regular C corporation is primarily used to reinvest profits to grow the business. Typically, more equipment and labor are needed to grow the business for long-term results. If your new business will grow with employees and overhead, and you want to grow an asset over time, a C corporation may be best for you.
Unfortunately, our industry has a lot of information suggesting that a C corporation is appropriate for most people. In many situations, the 21% C-corp tax bracket is lower than your overall personal rate, and therefore everyone should use a C corporation to pay lower taxes. That does work in year one — but unfortunately, any profit left in the corporation will be part of retained earnings and may be subject to double taxation in years to come.
If your home-based business goals are to have high profits and low overhead, you probably want to have your profits flow through, pay tax once, and invest the money into other assets to grow. That may be real estate, investments, or other businesses. That typically will be held in a separate entity from your operating business. Again, your goals are critical of what you plan to do with your business’s profits after years 1, 2, and so on (assuming there are profits).
Example: A consultant (with a different tax problem) or a plumber who provides services and has no other employees forms a C corporation. Their goal is not to add employees in the future but to be as efficient with their business as possible, control overhead, and increase their profit margin. For most businesses like these, a C corporation is the wrong entity. Granted, a C corporation does have important fringe benefits, but you do not want to obtain a few fringe benefits in exchange for paying double taxation.
The bottom line is; that if a C corporation is not best for your business model over the next 3-5 years, it is probably not the best entity for you. Bear in mind that there are exceptions like anything else. If your new business does not fit into this category, then the next step is to evaluate flow-through entities.
Step 2: A Flow-Through Entity Is Your Best Choice.
If you have determined that a C corporation is not best for you, the next step is to determine your options. They may include:
- – S Corporation
- – Single Member LLC
- – Single Member LLC taxed as an S corporation.
- – LLC taxed as an S Corporation
- – LLC taxed as a Limited Partnership
Sole proprietorships are not considered here as an option for two main reasons: from a marketing point of view, there is no value in being the owner/operator; and of course, from a liability point of view, even with insurance, you may find yourself financially paralyzed.
- Do you have a business partner? If not, an LLC taxed as a partnership is not an option unless you have an existing S- or C corporation that will act as a partner.
- Do you want S corporation taxation (filing Form the 1120S)? Note that we did not say, “Be an S corporation,” Rather, do you want to have your entity taxed as an S corporation? This includes an S corporation and an LLC taxed as an S corporation.
If you have foreign shareholders, C corporations, or an LLC taxed as a partnership or a limited partnership, and none may be a shareholder of your entity taxed as an S corporation. This is especially important if you plan to have investors down the road.